The Psychology of Trading

Post By: Renzo Bazargani

Psychology is defined as the mental characteristics or attitude of a person or group. In other words, it is about the mindset, the frame of mind and thought processes, which leads to one´s behavior and/or actions. As a result, habits and patterns are formed. Every aspect of one´s life is all about patterns; work, relationships, money, health, leisure and trading/investing. Therefore, mindset is your identity and identity is your choice, which is self-image and the sense of self validation (worthiness). And your self-image will determine whether you will be successful or not in every aspect of your life, so it is very important to be aware of self-sabotaging beliefs, which are nothing more than patterns at a subconscious level.

When it comes to Trading, it boils down to what specific actions you are taking on a daily basis - the mind then solidifies what you think and do into patterns. These patterns lead to your results, that is, Profit and Loss (PnL). Here is a quote from a very successful trader and someone I have an utmost respect for, Mark Minervini, “The difference between mediocrity and greatness lies in the fundamental belief that discipline is not merely a principle of trading but a principle of greatness. Managing risk requires discipline. Sticking to your strategy requires discipline. Even if you have a sensible plan, if you lack discipline, emotions will creep into your trading and wreak havoc. Discipline leads to habit. They can be good habits or bad ones; it´s a matter of what you discipline yourself to do over time.” So true and I couldn´t have said it better. Having the best trading strategy or system or methodology will not matter if you do not have the right mindset and discipline to be a consistent winner in this business.

So many people enter the trading/investing world thinking that they will make lot´s of money and become millionaires in a year or two. They have no strategy and more importantly no idea on how to manage risk. They could be lucky and win for some time, but eventually will blow up their account and lose. As a result, most will quit and the ones that stick around will realize that trading successfully is going to take more time and more knowledge than initially anticipated. That´s when they become serious and start concentrating on learning a ´real´ methodology and having rules. After a while of trading their methodology and modifying their rules along the way, they begin to see that their lack of success is from within (the difficulty of being disciplined and following their trading rules), which is normally due to some kind of fear. At this stage, more people will quit and the very few that stay around (the passionate ones) are determined to work on knowing themselves better, no matter what it takes. Every athlete, doctor or entrepreneur go through many years of learning, gaining knowledge (as well as self-knowledge), practicing, failing and hard work before they become great at what they do and make the big money. I always tell people that it takes at least a minimum of 10 years to become an ´expert´ in anything. Successful trading is no different.

Before I talk about the right mindset for successful trading, I want to point out all the fears of trading and the common errors people make in this business. The fears have a lot to do with one´s ego, and are as follows: 1. Being wrong; 2. Losing; 3. Missing out (FOMO); 4. Leaving money on the table. And here are the common errors: hesitating, not pre-defining risk, not exiting at the pre-defined risk leading to bigger losses, entering a trade before the set-up/edge/system is perfectly formed, not letting profits run, and mind freeze (choking). People are focused on the fears and that is why they will create these same outcomes over and over again. In addition, by not having the right discipline, bad habits (impulsive behavior) can be formed over time, such as revenge trading or playing catch-up or the urge to be always in the market because of the rush or not being consistent with the process or having biases, which is thinking/feeling what the market will do next and the urge to enter the market instead of waiting patiently for the perfect set-up. Once you have the right mindset to trade successfully, then all these fears/errors will simply disappear, because your focus has now changed and you have developed new skills (habits/patterns) over a period of time.

The right mindset for successful trading consists of:

• Pre-market preparation

• Thinking in probabilities

• A carefree state of mind to execute methodology comfortably and without errors

• Patience

• Focused in the moment (mindfulness) - being present & objective

• Consistency and without fear

• Post-market reflection

Since this post is about the Psychology of Trading, I will not get into the details on pre-market preparation and post-market reflection, which are self-explanatory. Pre-market preparation is simply the analysis of the market before the open, such as levels, trends, bull/bear scenarios, game plan, market breadth, volatility, market´s behavior, prior day´s range, economic calendar, etc. - basically my posts for PalmaFutures Newsletter. On the other hand, Post-market reflection is reflecting on the day´s performance, re-visiting every trade, looking for ways to improve, relaxing, and so on.

Thinking in probabilities is the key to successful trading. Unprofitable traders are focused on a trade per trade basis and have expectations. They are obsessed on the outcome, instead of focusing on the process. They always have a reason for putting on a trade, and if the outcome is a win, then they believe their reason was correct and feel good about it. The next time, they will go ahead and put on a trade for the same exact reason, thinking the outcome will also be a win, but instead that trade turns into a loss. Therefore, they get upset and feel betrayed, thinking that their reason or methodology was wrong and start becoming hesitant the next time around. Over time this becomes like a vicious circle; as a result they trade based on fear and keep making all the errors I mentioned above. Conversely, a profitable trader does not have expectations and see every trade as random, they are flexible and are only focused on the process by being in the present and objective, while waiting patiently for their set-up to be formed. Once they execute their trade, they genuinely don´t know what will happen, if it goes their way, they exit at their profit target and if it doesn´t, they exit at their pre-defined risk; no thinking required. They are fearless and have no emotions because they understand that their methodology does not guarantee a winner on a trade per trade basis, but rather on a series of trades, like let say 45 trades. Furthermore, they understand that the only reason the market moves (up or down) is because of the imbalance of conviction, that is, big buyer(s) move market up and big seller(s) move market down, and that market movement has nothing to do with one´s methodology or reasons - there is absolutely no correlation. So basically, you are dependent on the behavior of other traders to make your trade a winner and are using a mathematical formula or price patterns on a chart to predict what they will do (prices move through the imbalance of conviction and patterns are formed based on that imbalance). Therefore, if you win or lose in a trade, it has nothing to do with your methodology, system, edge or any other reasons. Once you change your perspective from a trade per trade basis (focused on outcome) to a series of trades (thinking in probabilities, no expectations, random outcome), then all those fears/errors mentioned above will disappear. This is exactly how you become a consistent winner.

However, you have to build these skills which will create the new habits for becoming a successful trader. First of all, your trading methodology and rules consists of risk parameters, money management (position size) and profit objectives. Simply, a trader is profitable because winning trades outnumber losing trades, and/or the average win is bigger than the average loss. Also, it is imperative to fully trust and have confidence in one´s trading system or methodology. Then you must commit to taking the next 45 trades following your methodology accurately, knowing the risk/reward for each trade and completely forgetting about the outcome on a trade per trade basis. When you are putting on the trades think in probabilities by managing your expectations for each trade. Once that´s complete, measure your performance for the 45 trades and then repeat the exercise again. Do this until you have no conflicting issues for taking trades easily and thinking in series of trades. Your goal is to trade consistently without fear.

Bottom line, successful traders think in probabilities, have no expectations, focus purely on making every trading decision a quality choice, follow their methodology with discipline, trade fearlessly and do it consistently day in and day out. Additionally, they know the statistics of their performance at all times and if their results start to vary from their usual outcomes, maybe due to a change of market behavior or some temporary personal issues or as mentioned above, due to self-sabotaging beliefs, then they make small adjustments, for example trading with less money or doing nothing until the circumstances change in the markets or at home. Moreover, great traders take care of their mind and body - they eat good, sleep well, exercise, meditate and use performance techniques like visualizations.

I really hope this post was helpful for you. If you have any questions or doubts, please do comment below. I also welcome any feedback.

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